3 Reasons Why It Might Be Time to Take Profits in Alcatel-Lucent

With the stock up more than 150% in the last 12 months, there are a few warning signs that investors need to watch.

Mar 31, 2014 at 1:00PM

There is an old saying in the market that no one ever got hurt by taking profits. This old adage is something that Alcatel-Lucent (NYSE:ALU) investors might want to remember. The stock is still up more than 150% in the last year, and there are at least three reasons to worry if this run will continue.

It's time to face facts
The first challenge facing Alcatel-Lucent is the fact that the company's operating margin just isn't as good as at least one of its peers. While some might debate the fact, the networking industry has become a bit of a commodity type business. Let's face it: companies looking to build their network may not care whether the router or switch says Alcatel-Lucent, Juniper Networks (NYSE:JNPR), or Nokia (NYSE:NOK) on the box.

What companies need from these networking businesses is greater efficiency, faster speeds, and less cost. When you get right down to it, a company with a superior operating margin should be able to compete on price if necessary and win against competitors with lower margins.

In the most recent quarter, Alcatel-Lucent reported an operating margin of just 7.8%, which was dragged down by the company's Access division's operating margin of just 3.8%. Given that Access makes up about 50% of Alcatel-Lucent's revenue, the company will have a hard time improving its margin until this relationship changes.

By comparison, Nokia has been struggling mightily with overall revenue in its Nokia Solutions and Networks business (almost 90% of revenue) down more than 20% on a year-over-year basis. Even in the face of this decline, Nokia still managed a continuing operating margin of 7.9%.

If investors had to pick one of the three above companies on margin results alone, the clear winner would be Juniper Networks. Not only is Juniper's current operating margin greater than 15%, the company expects this number to rise to 25% in the next two years. With this type of competition, it's hard to see Alcatel-Lucent delivering impressive results to shareholders.

More of the same
The second reason it might be time to take profits in Alcatel-Lucent looks a lot like the first. Not only is the company's operating margin lower than some of its peers, the company spends less on research and development (R&D) than these peers as well.

In the most recent quarter, the company spent 14.5% of its revenue on R&D. While this would be impressive in comparison to some other companies, Nokia spent 14.8% and Juniper spent 20%.

One thing that is almost as certain as death and taxes is that companies in the technology industry that don't outspend their competitors on R&D have trouble keeping up.

You can't dilute this issue
Peter Lynch once famously compared two companies that were going through difficult times. One company issued tons of new shares to fund expenses; though earnings recovered, the company's earnings-per-share growth was never the same. The second company didn't issue as many shares, and when business improved shareholders benefited.

History appears to be repeating Lynch's example as Alcatel-Lucent has issued a truckload of shares to stick around. This is the third reason it might be time to take profits in the networker. In the last year, the company's diluted share count has increased by 24%.

By comparison, Nokia's struggles have led to a 12% increase in shares, whereas Juniper has actually retired 1.5% of its shares.

Better options
Alcatel-Lucent has been on a tremendous run, but it might be time for investors to switch to Juniper Networks. Juniper carries better margins, spends relatively more on R&D, and is retiring shares.

In addition, Juniper pays a newly minted dividend that it expects to raise in the future. If that wasn't enough the company also expects to spend about $2 billion on share repurchases in the next two years. No matter how you slice it, Juniper just looks like the better option.

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